'Dollarization' in Latin nations sparks debate
The appeal 'dollarization' holds
for shaky
economies is that everyone trusts the U.S. dollar's value.
BY ROBERT A. RANKIN
AND KATHERINE ELLISON
Mercury News Staff Writers
WASHINGTON
IN Argentina, when you buy a home, a car, a taxi ride -- virtually anything -- you typically pay not with pesos, but with U.S. greenback dollars.
The same is true in Panama, in Liberia, increasingly in Russia, and in many other countries from the Caribbean to the South China Sea. In fact, about two-thirds of the 500 billion U.S. dollars in existence are now held outside U.S. borders, according to the Federal Reserve.
Argentina is even thinking about scrapping its peso entirely and making the U.S. dollar its official currency. Much of Latin America may follow within a decade, some Wall Street and Latin economists believe; they say the dollar is becoming for this hemisphere what Japan's yen is for Asia and the new euro will be for Europe -- the basic money unit for one-third of the world -- financing everything from global business to street-vendor sales.
Is this a good idea?
Yes, probably, for the United States at least, although experts say there are two possible risks. For foreign nations that ''dollarize'' their economies, however, potential risks and benefits are both considerably higher.
Some advantages to both sides are obvious: Business deals between countries with a common currency can be made without worry of exchange-rate fluctuations; there are no transaction costs at the border; and all trade, investment and economic relations between the countries gain a context of greater stability.
In addition, the United States gains up to $20 billion a year from ''seignorage'' earnings from interest on foreign bank accounts that finance the purchase of dollars. That's the biggest single direct U.S. advantage the trend offers.
The appeal ''dollarization'' holds for shaky foreign economies like Argentina's, however, is that everyone trusts the U.S. dollar's value. Deals done in dollars can be financed at low, steady interest rates that nourish the Argentine economy.
In contrast, Argentine banks must keep interest rates high to attract investors in peso-denominated assets because the peso's integrity is suspect. Those rates choke off economic growth. The collapse of confidence in foreign currencies from Thailand to Brazil that shook the global economy over the past two years has intensified pressure on foreign governments such as Argentina's to shift into U.S. dollars.
This dollarization trend threatens the U.S. economy with two risks, but experts say neither is great. One is resurgent inflation. The U.S. money supply has grown far faster than the U.S. economy for almost two decades. Monetarist theory says that is a sure recipe for inflation, although its failure to ignite so far has mystified them for years.
So long as much of the excess money supply is held abroad however, it is not bidding up U.S. prices, so it is not inflationary. The risk is that ''those dollars could come back to the U.S. just as easily as they left, which could cause a severe bout of inflation,'' according to Edwin S. Rubenstein, research director at the Hudson Institute, a conservative think tank.
If that were to happen, the Federal Reserve would be forced to raise interest rates both to quell inflation and to lure foreign investors back into dollars. That ''might cause a recession,'' Rubenstein wrote in the current edition of American Outlook, the institute's quarterly magazine.
In an interview, however, Rubenstein acknowledged that that second threat of recession is more theoretical than real, because individuals abroad are unlikely to dump dollars. ''The dollar's value is pretty well determined by what we do in the U.S., not by dollars held abroad,'' he said.
Only if the Fed permitted inflation to rage out of control again, as in the 1970s, would a flood of foreign-held dollars be likely -- but the Fed is credibly determined to keep inflation low and steady, as it has through this decade.
Even Allan Meltzer, one of the nation's foremost monetarist economists, agrees that the risk of foreign dollarization sparking U.S. inflation is remote. ''The only real risk is if the Fed bailed out their financial institutions'' when they sink into debt crises, said Meltzer, a professor at Carnegie Mellon University in Pittsburgh.
That won't happen, assures Fed Chairman Alan Greenspan.
If foreign economies dollarize, ''we would have to be particularly careful to remember that our monetary policy is first and always for the United States. We cannot be a central bank for the United States and others,'' Greenspan told the Senate Banking Committee last week. ''And in that context, we have to be careful not to be perceived as creating a safety net for institutions in dollarized economies,'' he emphasized.
So long as Greenspan's standard applies, foreign dollarization poses little risk to the U.S. economy -- but it poses large ones to countries abroad that adopt it.
That's because they would be surrendering control over their economies to the U.S. Federal Reserve. If their economies plunged into recession, they would be unable to cut interest rates to provide relief.
''It's basically a straitjacket monetary policy. . . . It's really a very rigid regime,'' Deputy Treasury Secretary Lawrence Summers said in Senate testimony earlier this year.
Foreign countries that adopt the U.S. dollar would not be able to print money to finance budget deficits and would have no ''lender of last resort'' central bank to turn to when their banks collapsed in debt.
Yet they would gain a credible currency able to lure investors at low interest rates into their countries. ''There are potentially very large advantages in terms of stability, in terms of locking in a regime,'' Summers observed.
Argentina thinks the benefits of full dollarization may outweigh the risks. It is discussing the option with U.S. Treasury and Fed officials, but there is no formal proposal yet.
''There is a determination in the Argentine government, but it takes two to tango,'' said Martin Redrado, an influential economic consultant in Buenos Aires.
Argentina envisions itself as a potential pilot project aimed at making the dollar the de facto currency throughout Latin America within 10 years, Redrado said, adding, ''The U.S. is listening closely to our proposals, listening carefully.''
Treasury and Fed officials will not comment on the record, but they say Argentina has made no formal proposal to Washington regarding dollarization, and while informal talks are being held, negotiations are not. Moreover, administration officials are emphatic in stressing that the U.S. government will never share management of U.S. monetary policy with any other country, even those that dollarize their economies
J.P. Morgan, the banking giant, published a research paper last month exploring the possibility that the dollar may become for the Americas what the new euro is for Europe. While noting that the Americas are split by such wide political and economic differences that a euro-style central bank currency regime is impossible, the Morgan study nonetheless suggests that Latin governments are being driven by market forces to ''dollarize'' their economies unilaterally.
''The world is headed the way of three regional currency blocks -- Europe, Asia and the Americas,'' the Morgan study said.
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Robert A. Rankin is a reporter for the Mercury News Washington Bureau and Katherine Ellison for the Mercury News Rio de Janiero Bureau.
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